Is the Chinese growth model somehow unique? Contrary to what many have argued, Michael Pettis presents a compelling case as to why not – demonstrating that despite bucking the mainstream (IMF / World Bank) policy recommendations for development, the growth model that has served China well in recent decades is a variant that has proved successful for various countries over the last three centuries…. The debate centers around the role of economic doctrines of free trade vs the benefits of protectionism, and finishes off debating some of the structural impediments to continued rapid development in China:

What works in development? Comparing development models

A summary of “some of the important points about the American System and other similar growth models, like the Chinese version.

1. Infant industry protection has worked to promote long-term development under certain conditions and has not worked under other conditions. I would argue that the key difference is that in the former case there were powerful forces that drove managerial and technological innovation and rapid growth in efficiency.

In the US case this seems to have been brutal domestic competition. If China wants to benefit from its own protection of infant industry, it is important that there be similar domestic drivers of innovation and efficiency. Note that access to cheap capital cannot be such a driver, even though it is one of the main sources of Chinese competitiveness. Access to cheap capital is just another way to protect infant industries from foreign competition.

2. Every country that has become sustainably rich has had significant government investment in infrastructure, but not every country that has had significant government investment in infrastructure has become sustainably rich.On the contrary there are many cases of countries with extraordinarily high levels of infrastructure investment that have grown for a period and then faltered.

I would argue that the difference is almost certainly the extent of capital misallocation. In some countries it has been much easier for policymakers to drive capital expenditures, and in those countries it seems to have been relatively easy to waste investment. If this is the case in China, as I believe it is, the key issue for China is to rein in its spending and develop an alternative and better way to allocate capital.

The point is that there is a natural limit to infrastructure spending, and this limit is often imposed by institutional distortions in the market economy. When this natural limit is reached, more investment in infrastructure can be wealth destroying, not wealth enhancing, in which case it is far better to cut back on investment and to focus on reducing the institutional constraints to more productive use of capital, such as weak corporate governance and a weak legal framework. The pace of infrastructure investment cannot exceed the pace of institutional reform for very long without itself becoming a problem.

3. Any economy looking to achieve sustainable long-term growth must have a “good” financial system that allocates capital efficiently and rewards the correct level of risk-taking. It is hard to determine what the characteristics of a “good” financial system are, but we shouldn’t be too quick to assume that this has to do with stability.

What’s more, while obviously the capital allocation process is vitally important, I would also suggest that the liquidation of bad loans is just as important. Bad loans, as Japan showed us in the past two decades, can become a serious impediment to growth in part because financial distress distorts management incentives in the way widely understood and described in corporate finance theory and in part because they retard the process by which bad investment is absorbed by the economy.

James Fallows, in an article published over 20 years ago, makes a number of points echoed by Pettis:

“BRITONS and Americans tend to see the past two centuries of economics us one long progression toward rationality and good sense. In 1776 Adam Smith’s The Wealth of Nations made the case against old-style mercantilism, just as the Declaration of Independence made the case against old-style feudal and royal domination. Since then more and more of the world has come to the correct view—or so it seems in the Anglo-American countries. Along the way the world has met such impediments as neo-mercantilism, radical unionism, sweeping protectionism, socialism, and, of course, communism. One by one the worst threats have given way. Except for a few lamentable areas of backsliding, the world has seen the wisdom of Adam Smith’s ways.

Yet during this whole time there has been an alternative school of thought. The Enlightenment philosophers were not the only ones to think about how the world should be organized. During the eighteenth and nineteenth centuries the Germans were also active—to say nothing of the theorists at work in Tokugawa Japan, late imperial China, czarist Russia, and elsewhere.

The Germans deserve emphasis—more than the Japanese, the Chinese, the Russians, and so on because many of their philosophies endure. These did not take root in England or America, but they were carefully studied, adapted, and applied in parts of Europe and Asia, notably Japan. In place of Rousseau and Locke the Germans offered Hegel. In place of Adam Smith they had Friedrich List.

For a more critical look at how these themes play out in modern-day mainstream development doctrines, a piece by cambridge economist Ha-Joon Chang: “Kicking Away the Ladder”, post-autistic economics review, issue no. 15

There is currently great pressure on developing countries to adopt a set of “good policies” and “good institutions” – such as liberalisation of trade and investment and strong patent law – to foster their economic development. When some developing countries show reluctance in adopting them, the proponents of this recipe often find it difficult to understand these countries’ stupidity in not accepting such a tried and tested recipe for development. After all, they argue, these are the policies and the institutions that the developed countries had used in the past in order to become rich. Their belief in their own recommendation is so absolute that in their view it has to be imposed on the developing countries through strong bilateral and multilateral external pressures, even when these countries don’t want them.

Naturally, there have been heated debates on whether these recommended policies and institutions are appropriate for developing countries. However, curiously, even many of those who are sceptical of the applicability of these policies and institutions to the developing countries take it for granted that these were the policies and the institutions that were used by the developed countries when they themselves were developing countries.

Contrary to the conventional wisdom, the historical fact is that the rich countries did not develop on the basis of the policies and the institutions that they now recommend to, and often force upon, the developing countries. Unfortunately, this fact is little known these days because the “official historians” of capitalism have been very successful in re-writing its history.